DeFi yield farming and its remunerative benefits to Liquidity Providers

What is Yield Farming?

Decentralized Finance, or DeFi for short, is an open-source protocol that provides permission-free and fast financial services. The process by which users provide liquidity to DeFi open source protocols and receive rewards in return is known as DeFi Yield Farming.

Simply put, the process of yield farming performed on platforms built with DeFi protocols offers native DeFi tokens of the respective platform, and this process is referred to as DeFi Yield Farming.

Yield farming protocols encourage liquidity providers (LPs) to lock their crypto assets in a liquidity pool based on smart contract solutions. A portion of transaction costs, interest from lenders, or a governance token can be received as rewards. These returns are calculated as an annualized percentage yield (APY). The value of the released returns decreases as more investors allocate funds to the associated liquidity pool.

The most common DeFi protocols run on the Ethereum network and offer governance tokens for liquidity mining. After offering liquidity on decentralized exchanges, tokens can be mined in liquidity pools.

Also read | How to create a decentralized financial protocol (DeFi) like Yearn. Finance

Important terminology in yield farming:

What is liquidity?

Liquidity refers to the ability of the asset to be converted into cash. In the crypto world, when an asset is bought or sold more, the market becomes competitive.

What are DEFI liquidity pools?

Liquidity pools are smart contracts that lock tokens or assets to facilitate trading by providing high liquidity. Liquidity pools offer users better returns than money markets, but also carry some risks.

Uniswap and Balancer are the most popular DeFi platforms, referred to as the largest liquidity pools.

Who are the DeFi liquidity providers?

The users who deploy their assets in the liquidity pools are called liquidity providers. Liquidity providers are also called market makers because they deliver what buyers and sellers want to trade.

How does DeFi Yield Farming work?

Yield farming is referred to as an automated market maker.

First, liquidity providers pay their assets or funds into the liquidity pool. This liquidity pool provides a marketplace where users or LPs can lend, borrow or trade their tokens or assets. These platforms charge fees that are then returned to liquidity providers based on their share of the liquidity pool.

However, the procedures may vary depending on the technology and approach. The funds deposited are mostly stable coins pegged to the USD. DAI, USDT, BUSD are the most commonly used stablecoins in DeFi Yield Farming.

How are the yields calculated in DeFi Yield Farming?

Estimated returns in Yield Farming are calculated on an annual basis. The key metrics for calculating yield in Yield Farming are Annual Percentage Yield (APR) and Annual Percentage Yield (APY).

Annual Percentage Yield (APY):

The annual percentage yield is charged to borrowers and paid to providers. It takes into account compound interest, which refers to the reinvestment of earnings to generate further income.

Annual Percentage Rate (APR):

The annual rate of return imposed on borrowers and paid to investors is called the APR

DeFi should find its own benchmarks for calculating returns in yield farming

Risks in DeFi Yield Farming:

Defi farming involves depositing funds into a smart contract with no central authority. And if the smart contract codes are lost and turn out to be a mistake, the entire financial transaction is also lost. This means that the funds transferred are lost. This causes farmers to lose all their assets when the system is blocked.

If DeFi smart contracts are free of vulnerabilities, the risks associated with DeFi Yield Farming can be reduced.

What triggered the rise of high-yield farming?

The introduction of the COMP token – the governance token of the compound finance ecosystem – has sparked strong interest in yield farming. Token holders receive privileges for governance tokens

Algorithmic distribution of these governance tokens with liquidity bonuses is a common way to kick-start a decentralized blockchain. Liquidity providers are enticed to “manage” the new token by providing liquidity to the protocol.

COMP has increased the popularity of this form of token distribution model. Other DeFi companies have also come up with creative ways to bring liquidity to their ecosystem.

What are the advantages and disadvantages of yield farming?

  • The main advantage of yield farming is profit. Yield farmers who implement a new project are rewarded with tokens, and large profits can be made if yield farmers sell certain tokens at the right time. These profits can be reinvested in other DeFi projects to further increase returns.
  • Yield farmers usually need to invest a significant amount of money upfront to make significant profits. Due to the high volatility of cryptocurrencies, especially DeFi tokens, yield farmers face a large liquidation risk if the price drops unexpectedly, as was the case with HotdogSwap.
  • Yield farming techniques are complicated, and those who don’t fully understand the underlying protocols are taking a greater risk.
  • Yield farmers have their money on project teams and their underlying smart contract code. Many developers and entrepreneurs start projects from scratch or even copy the code of their predecessors. Even if the project team is trustworthy, the code is often untested and prone to bugs, making it vulnerable to attackers.

Key challenges and opportunities in yield farming:

The Ethereum blockchain is used for the majority of DeFi applications, which presents some significant challenges for yield farmers. The Ethereum network is experiencing scalability issues in advance of the 2.0 update. As yield farming becomes more widespread, the Ethereum network falters, leading to long confirmation times and rising transaction fees.

As a result of this scenario, some have speculated that DeFi could end up cannibalising itself. Ethereum’s problems, on the other hand, seem more likely to support other networks in the long run. The Binance Smart Chain, for example, has become a viable alternative for yield farmers who have flocked to the network to take advantage of new DeFi DApps like BurgerSwap.

In addition, Ethereum’s existing DeFi operators are trying to solve the problem with their second-layer solutions for the network. So, assuming that Ethereum’s problems do not prove fatal to DeFi, Yield Farming will continue to exist.

The Future of DeFi Yield Farming:

DeFi Yield Farming offers users attractive returns that are at least a hundred times higher than a traditional bank on their deployed crypto assets, and pushes the DeFi space to the next level of the crypto market.

In the future, there could be more and more DeFi-based platforms with automated yield farming that will shake up the crypto world. This yield farming has inspired many people and will attract many more in the near future.

Brugu’s expertise in developing yield farming platforms:

  • Brugu always keeps up to date with the latest developments and trends in DeFi and cryptocurrency. As soon as you decide to start Yield Farming, first contact our team of top specialists.
  • Our team consists of elite developers, business analysts, and marketers who will unconditionally support your project to guarantee its success
  • Brugu has earned a reputation for its DeFi development solutions and services, and all of our services are customizable.
  • We have begun supporting DeFi-based projects primarily for aggressive growth in agriculture
Brugu Written by:

Brugu team contributes the time on blockchain research to gain knowledge and maintains consistency in implementing the best practices on development of software".The team develops decentralized business applications and blockchain technology integrated business solutions to transform and improve traditional business processes. Every obstacle to start blockchain business has to be abolished if we want to build a better and brighter business growth.

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